What is the purpose of class actions? To provide compensation to class members? Or to provide compensation for attorneys? The Seventh Circuit has taken a skeptical view of settlements that provide fees for counsel but no meaningful benefit for the class. But there is a circuit split on the question, with the Ninth Circuit approving settlements that maximize attorney fees at the expense of the class, while funneling the class’s compensation to organizations already supported by defendant contributions.
The U.S. Supreme Court granted cert in Frank v. Gaos to consider whether and in what circumstances cy pres is permitted in class action settlements.
Class counsel brought a putative class action against Google alleging Stored Communications Act violations entitling over 100 million class members to $1000/violation statutory damages. Before a motion to dismiss could be decided, the parties settled. Class counsel would receive over $2.1 million (over $1000/hour for every lawyer who worked on the case) and the class would receive nothing. The parties justified this settlement because of a provision providing for cy pres donations: about $5 million to five organizations that would use the money on Internet-related issues. At the fairness hearing, class member Ted Frank objected that the settlement unfairly benefited class counsel at the expense of the class, and objected that the cy pres money was going to organizations affiliated with Google or class counsel, such as Chicago-Kent Law School, the alma mater of one of the attorneys. The district court stated the cy pres did not pass the “smell test,” but approved the settlement under Ninth Circuit precedent, and the Ninth Circuit affirmed.
Ted Frank, litigation director at the Competitive Enterprise Institute, argues that a settlement where attorneys receive millions and the class receives nothing by definition fails the Rule 23(e) requirement that settlements be “fair, reasonable, and adequate.” A bright line rule on “fairness” requiring that attorney fees be proportional to the direct recovery to the class would provide guidance to lower courts, align counsels’ incentives with the class they represent, and reduce the incentive to bring low-value class actions that function as a mechanism to extract fees.
The New Jersey Civil Justice Institute filed an amicus brief in the case. Alida Kass, president and chief counsel, will discuss the questions at issue in Frank v. Gaos. The argument is scheduled for October 31.
Alida Kass, President and Chief Counsel, New Jersey Civil Justice Institute
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Operator: Welcome to The Federalist Society's Practice Group Podcast. The following podcast, hosted by The Federalist Society's Litigation Practice Group, was recorded on Tuesday, October 30, 2018 during a live teleforum conference call held exclusively for Federalist Society members.
Wesley Hodges: Welcome to The Federalist Society's teleforum conference call. This afternoon's topic is a Courthouse Steps Preview for an important case set before the Court tomorrow. It's titled Frank v. Gaos. My name is Wesley Hodges, and I'm the Associate Director of Practice Groups at The Federalist Society.
As always, please note that all expressions of opinion are those of the expert on today's call.
Today we are very fortunate to have with us Ms. Alida Kass, who is President and Chief Counsel for the New Jersey Civil Justice Institute. The New Jersey Civil Justice Institute filed an amicus brief in the case. After our speaker gives her remarks, we will move to an audience Q&A, so please keep in mind what questions you have for the case or for Ms. Kass today. Thank you very much for speaking with us. Alida, I believe the floor is yours.
Alida Kass: Thank you so much. It's a privilege to be here. This is a case that the New Jersey Civil Justice Institute was really pleased to be able to participate in, and we're really looking forward to the oral argument tomorrow.
I think as a -- just at a big-picture level, what's so interesting about this case is it really goes to the heart of the question of what is the purpose of class actions? Is it to provide compensation to class members, or is it to provide compensation to attorneys? And that's not a trick question. There's actually a circuit split on the question of whether courts can approve settlements that provide fees for attorneys and no direct compensation to actual class members.
So class actions are permitted under Rule 23, but Rule 23(e) requires that settlements be "fair, reasonable, and adequate." And the question is what does that mean? This case began with Gaos v. Google, where class counsel brought a putative class action against Google alleging Stored Communications Act violations that arguably entitled 100 million class members to $1,000 per violation statutory damage penalty. The parties settled before a motion to dismiss for $8.5 million total. Of that sum, class counsel would receive over $2.1 million, the class would receive nothing. But a number of private charities would receive cy pres donations, totaling about $5 million. All of those private charities named were affiliated either with Google or with class counsel.
So Ted Frank of CEI objected, pointing out that the settlement was benefitting class counsel but was not really benefitting the class. Google responded that the total settlement value distributed amongst the entire class would amount to about 4 cents per class member which would not really be feasible to distribute, and that the trial court had reviewed the settlement and upheld it. And that these courts are in the best position to determine what is fair, reasonable, and accurate -- sorry, adequate. And that the class as a whole benefits more from the $5 million going to organizations who will spend the money on internet-related activity than by receiving a modicum of recovery. And the Ninth Circuit permits cy pres when it's infeasible to distribute to the class, which in the Ninth Circuit means, essentially, whenever there's a large class and a prorated distribution of all class members would result in an infeasible dollar value, regardless of how many would be likely to make a claim.
So the Supreme Court granted cert to consider the question of whether and in what circumstances cy pres is permitted in class action settlements. And all of this, I think, raises a number of pretty interesting questions.
The first is the question that I started with: what is the purpose of class action litigation? Rule 23 is a procedural device to promote efficient resolution of disputes and allow relatively low dollar-value claims to which would not be economically efficient to bring individually to proceed as a group because only a lunatic or a fanatic sues for $30. But there's a difference between aggregating individual claims that would not otherwise be brought and claims of such low value that it isn't even feasible to distribute.
If the argument is that compensation cannot feasibly be delivered to class members, then plainly that is not a class action whose purpose is compensating the class. If there's zero benefit going to the class but attorneys are making millions, it starts to look like a case brought primarily to benefit the attorneys. But the cy pres provides benefit to the class as a whole more so than if the recovery were actually distributed to class members is the argument. But the funny thing about that is class members have given up whatever claims they might have had so that unrelated parties over there can receive millions of dollars. And to the extent anyone benefits from the internet-related work done by private charities, everyone benefits roughly equally. So it's only the class members who have given up their claims. And so arguably now, it's the class members who are now worse off as a result of the class action settlement.
So NJCJI's amicus argued that a class with no direct benefit to the -- sorry, a class settlement with no direct benefit to the class also fails (b)(3) superiority requirement, and the State AG's amicus made a similar argument.
Now, that gets to the third interesting question raised by this case which is the question of incentives. Overwhelmingly, the majority of class actions result in settlements, so the standards for settlements and the incentives that they create are really important questions. The standard under Rule 23 that settlements be "fair, reasonable, and adequate," Ted's argument is that those words have meaning, and that they require something more than an observation that both parties have agreed to the terms. Fairness in particular suggests some proportionality of compensation to attorneys and to the class that they represent. If attorneys are recovering fees and the class is recovering nothing, Ted Frank's argument is that that's not consistent with basic fairness. His argument is that that is the best reading of Rule 23(e). But that reading also has an effect on correcting existing distortions in the incentives in class actions.
First, the rule of proportionality aligns incentives of attorneys with those of the class members they would represent. Without that rule, the interest of class members and other participants to the litigation will diverge. Class counsel has an incentive to obtain a large fee; defendants are largely indifferent to how their payment is distributed, but with the settlement structured around cy pres, they both win. The cy pres payment justifies the attorneys' fees and the defendants get the PR benefit of a charitable contribution, often to a charity they were supporting anyway which minimizes their actual true cost. And if there's no obligation to get recovery to class members, if there's a gravy train at the end of the process regardless of whether the class receives any direct benefit, then there's no incentive to compensate the class.
On the other hand, if the attorneys' fees must be proportional, not to the contributions made to unrelated third parties, but to the class members themselves, then attorneys' and class members' incentives will align. And Ted's argument in this case is of course it's feasible to get money to the class. Infeasibility should not be based, Ted would argue, on the sheer size of the class, as is the standard in the Ninth Circuit, because claims rates in class actions are ridiculously low. So create a pool of money for making the claims and allow the claims to exhaust the pool. And Fraley v. Facebook, a nearly 150 member class -- they were able to successfully distribute settlement funds because 600,000 members made a claim, and they recovered $15 each.
But then, hypothetically, again for the purposes of an incentives analysis, in cases where it's not feasible to distribute to the class members, a bright line of rule of proportionality consistently applied by lower courts would also correct incentives in the cases that are actually brought. If class members are not receiving direct compensation, that means -- sorry, if class members are not receiving direct compensation and that means attorneys will not receive compensation, then the attorneys are much less likely to bring those cases. And that is arguably a good thing because conceivably, these are the low, social-value cases. Again, going back to the purpose of class actions – if the class members won't be compensated, there's little value in those cases themselves.
I think there are arguments made about the deterrent value of class actions, but what's interesting about this particular case is the deterrent value is built into the underlying statute. The Stored Communications Act provides for a $1,000 per violation statutory penalty. So it was designed to make individual claims feasible. Google's argument here is that it was such a weak case that it was settled for so much less than full statutory penalty value. And shouldn't they be able to reach a low-value settlement commensurate with the strength of their case? And arguably, the answer is if it's such a weak case that members aren't entitled to compensation, then neither are the attorneys. Why would we want to compensate, reward attorneys for bringing low, social-value cases?
So that is my overview of the issues that are at stake in this case. And I think looking ahead to possible outcomes, the Court may adopt a rule of proportionality or some other mechanism to limit the incentives to bring class actions for, primarily, purposes of compensating attorneys. There's certainly Ted Frank's argument, which is bright line rule of proportionality. The State Attorney General's amicus argued that cy-pres-only settlements are, per se, invalid under Rule 23(b)(3), and that cy pres awards cannot be used to justify attorneys' fees. There's a slightly related argument from the U.S. Chamber arguing for clarity to the lower courts that no injury class actions should not be certified. Google is arguing a standing question that the case should be dismissed or improvidently granted, that because this is a statutory penalty situation with disputed underlying harms that it doesn't meet Spokeo Article III standing.
And then the Court might uphold and affirm the Ninth Circuit approach, and there were amicus arguments made on behalf of private funds and foundations that rely on cy pres awards. But then I think that gets back to the question about what's the purpose of class actions. When I started, I didn't even the question that the alternative answer of maybe the true purpose is to support private foundations organized in public policy work. But arguably, that's not really a legitimate purpose either, even though I think we recognize that there are a number of entities that benefit greatly from cy pres awards. And I think the risk of upholding and affirming the Ninth Circuit approach is the trajectory for class actions as a mechanism for providing any direct benefit to class members.
Cy pres has been increasing, both in frequency and as a share of overall settlement value. Justice Roberts noted that cy pres was a growing feature of class actions when cert was denied a few years ago in Marek v. Lane. And if the Court blesses the free use of cy-pres-only distributions whenever there's a large class relative to the total settlement value, there will be a much stronger incentive to structure class settlements in a way that provides no recovery to the class. Arguably, right now the only incentive to compensate the class is really the concern that the settlement might not otherwise be approved. And I will note from the perspective of the New Jersey Civil Justice Institute that presents a particular problem from the perspective of organizations based in New Jersey because the Third Circuit approach to this actually includes a specific consideration of the degree of direct benefit to the class. And while excess funds can be distributed by cy pres, they should represent a small percentage of the total settlement funds.
So because most class actions are nationwide opening the door to forum shopping into the jurisdiction with the most permissive standards for plaintiff's attorneys to collect fees, arguably, we would really be in a world where class actions exist to provide compensation for attorneys. So that's my overview of this, and then I will turn back for any questions.
Wesley Hodges: Excellent. Thank you so much, Alida. While we wait for any questions from the audience, Alida, I did want to ask you, could you share just some examples of stories of cy pres gone wrong or too far?
Alida Kass: Yeah. I mean, I think it's an interesting question. I would say, arguably, the situations -- certainly situations where it's cy-pres-only are examples of where it's gone wrong. But I think sometimes, like the Pearson case – Pearson v. NBTY – was an interesting case where you had, I think it was $4.5 million, almost none to the class, and that was a Seventh Circuit case. Seventh Circuit remanded, and when the attorneys were actually at risk for not getting their fees, the defendants were at risk for not getting their settlement approved, they found a way to get the money to the class. And so I think that's a great example of where, I think, there are good, textual arguments for why this is sort of a good reading of Rule 23. But it's really interesting to observe sort of "in real time" how the incentives guide the behavior of the parties in these litigation settlements.
Wesley Hodges: Great. Thank you. Looks like we do have one question from the audience. Let's go ahead and move to our first caller.
Caller 1: Hi. Is this case going to have any impact on a class action where there actually is -- let's say it's a claims-made settlement. There's a pot of money and claims are made, but there's a residue and agreement, class action settlement agreement approved by the judge, has a cy pres for the residue. Is this case going to have any impact on what criteria the district judge should be using and approving or disapproving the selection of the cy pres, or even, I guess, worse case for plaintiffs in class actions, is it going to have any impact on judges saying "no longer cy pres to charities. Money all reverts to the settlor, the company, the employer, whatever it may be?"
Alida Kass: Yeah, I think that's an interesting question. I mean, obviously, it sort of depends on what the Court decides to do with it. I don't know that -- just of the arguments that I've seen made in the briefing, I think to the extent that there's been a concern about the specific beneficiary of the cy pres, it's been that sort of conflict of interest concern that it, for example, should not be going to a particular counsel's alma mater or something like that. The sort of things that just look bad. But as far as that residual amount, I think -- you know, many of the arguments even arguing strongly for the rule of proportionality and things like that, those arguments seem amenable to residual cy pres going to some sort of charity or reverting to the state even. But I think to the extent that there's an argument about where it goes, when it's sort of properly cabined and limited, it's more on a -- the concern's more with a central conflict of interest than a particular charity.
Caller 1: Thanks.
Wesley Hodges: Thank you, caller. Seeing no more questions from the audience, Alida, we're very thankful for your remarks today. Do you have anything more you'd like to add or any closing thoughts?
Alida Kass: No, not really. I mean, I think this is just -- it's going to be -- obviously, it's going to be a really interesting argument tomorrow. I think of particular interest was Justice Robert's comments when cert was not granted, I think it was 2013, maybe. And so, it'll be -- I think watching the argument, it'll be especially interesting to see how he directs his questions to see what -- if there's a range of possible paths that the Court can take here. So it'll be interesting.
I think, obviously, the teleforum tomorrow, Courthouse Steps on post-argument, will be a really interesting one as well.
Wesley Hodges: Absolutely. It looks like a member of the audience did chime in with a question while you were speaking. So let's go ahead and turn to them before we finish today.
Roger (sp): This is Roger [inaudible 17:58]. Thank you for a good presentation. Forgive me if you already covered this in the first part, which I missed from tuning in a little late, but to put it bluntly, how much money are we talking about? That is to say, depending on how the Court may rule, what would be the magnitude of the shift in dollars over the next, say, 5, 10 years? 20 years? Just in terms of a guesstimate.
Alida Kass: Oh gosh. That's a great question. And in terms of actual dollars, I confess I'm just -- I don't have the [inaudible 18:39] of the foundation to offer an intelligent answer to that. The one thing that I will say, which I think is so interesting about this particular case, is you’ve had cy pres just kind of there. It's never been expressly approved, disapproved by the Supreme Court. It's kind of just been there. And what's so interesting about the cert grant here is the trajectory sort of changes almost no matter what they do. As I kind of mentioned, to uphold this and permit it doesn't sort of continue the situation that we have as it stands now because once it's permitted, that concern about sort of a fig leaf of dispensability for compensation to the class, if you take that away, I think whatever the dollar value is it gets much higher going forward. So I apologize that I can't really answer the question in a pure dollar-and-cents term. But I'll, if you tune in tomorrow, I'll warn our colleague who's going to be handling the Courthouse Steps tomorrow, and he might be able to answer it.
Roger: Okay. Thank you.
Wesley Hodges: Thank you very much for your question. Seeing no more questions, Alida, one more time back to you. Any thoughts before we close today?
Alida Kass: No. I mean, that's about it. But I would encourage anyone on the call today to tune in again tomorrow because I think it's going to be really interesting to rehash whatever happens at the oral argument tomorrow.
Wesley Hodges: Thank you. Of course, we do agree, and we're very grateful for your time today, Alida. On behalf of The Federalist Society, I'd like to thank you for the benefit of your valuable time and expertise. We welcome all listener feedback by email at firstname.lastname@example.org. Thank you everyone for joining. This call is now adjourned.
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